Fundamentals of Operations Mgmt Supply Chain Coordination November, 2012

1. Fundamentals of Operations MgmtSupply Chain CoordinationNovember, 2012

2. Supply Chain Logic is similar to Project Management & MRP

3. Supply Chain Coordination is filled with Challenges Interdependent performance complicated by: • Distance • Time • Physical size and space • Consumer taste • Competitor action • Unequal use of technology • Unequal willingness to share information • Unequal financial solvency • Integrated ability (or inability) to deliver • Frequent conflicts of interest • “Bullwhip effect” Essentially nothing takes place in isolation of something else

4. Bullwhip A slight flick of the wrist creates severe disruption by the end of the whip http://www.youtube.com/watch?v=aywseTNOiYI http://en.wikipedia.org/wiki/Bullwhip_effect

5. Bullwhip Effect in the Supply Chain Factory Customer Retailer Distributor Supplier Equipment A slight change in customer demand results in adjustments at each tier, resulting in major distortion between the beginning and end of the chain * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

6. Example of Bullwhip Effect in the U.S. PC Supply Chain Annual % changes in demand (in $s) at three levels of the semiconductor supply chain: personal computers, semiconductors and semiconductor manufacturing equipment. There is an appearance of volatility in the chain, despite relative stability of final demand * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

7. Reactive and over-reactive ordering “A little extra” Scarcity Behavior Shortage gaming Order synchronization Order batching Trade promotions and forward buying Causes of the Bullwhip Effect

8. Reactive and over-reactive ordering • When actual demand varies from what was forecasted, it is necessary to determine how the near term variance signals future demand: • Increase? • Decrease? • Early? • Late? • “Noise”? • The tendency for suppliers is to avoid possibly shorting a customer, so there is a bias toward over-reacting and believing that the extra near term demand is a signal of an upward shift in future demand • Each level of the Supply Chain then sees increased demand (often aggravated by lot-sizing and batching policies) from its customer and the over-reaction repeats itself (Bullwhip effect) multiple times

9. A variation on reactive & over-reactive ordering: “A little extra” • Inflated forecast • Early forecast • Compound safety stocks • Inflated Lead Times • Large Batch sizes

10. Scarcity Behavior and other responses to Allocated Supply • When customers fear future supply disruption or shortages, they order extra quantities while supply is still available (e.g. “stocking up” before a storm) • When overall Demand exceeds overall Supply, the limited supply can be “Allocated” among customers in several ways: • First Come First Served • Customer priority • “Fair Share” (i.e. if 90% of demand can be satisfied, all customers receive 90% of their orders) • Other • During allocation, customers can “game” the system by over-ordering, expecting to receive a fraction (“order double, get half, get all you need”) • Once the “real” amount is received, additional orders are cancelled, creating major disruption up and down the chain

11. Trade promotion (temporary “deal” to retailer) creates incentive for retailer to buy much more than what will be sold in the near term. Promotions follow cycles that retailers come to expect Promotion often loses impact to producer because retailer buys enough to cover demand until next “deal” is offered, and avoids paying full price Exploiting promotions requires healthy balance sheet Shelf life / shifts in consumer taste / inventory carrying risks must be considered Repeated quarterly patterns of non-linear buying (“Hockey Stick”) are a variation of trade promotion behavior Trade promotions and forward buying Example: Campbell’s Chicken Noodle Soup over a one year period: Total shipments vs. consumption One retailer’s buy 7000 6000 Shipments 5000 4000 Cases Cases 3000 Consumption 2000 1000 0 Jul Jun Jan Sep Oct Feb Apr Aug Nov Dec Mar May Time (weeks) * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

12. Consequences of the Bullwhip Effect Increased volatility resulting in: • De-coupling of true Supply and Demand • Distorted priorities • Supply shortages • Customer dissatisfaction • Production inefficiency • Poor utilization of productive capacity • Excess inventory • Higher costs • Lost revenue • Order cancellations

13. Avoiding the Bullwhip Effect

14. Operations Leverage on Break Even and ROIC Work the Numerator and Denominator of Cash Generated Cash Invested • Attack TVC • Reduce Variability • Align Production with Revenue • Focus on Speed and Responsiveness instead of Inventory • Influence Fixed Costs • Hiring • Plant & Property • Equipment

15. Control limits to trigger forecast adjustments, with constant monitoring of actual final-consumer consumption Smaller batch sizes and more frequent replenishments leveraging: Point Of Sale data analysis Vendor Managed Inventory (VMI) Distribution network to leverage law of large numbers Smooth flow of production to better utilize capacity and leverage the law of large numbers Coordination with customers to spread deliveries more evenly, with selected buybacks along with limited returns and order cancellations Every day low price, and incentives for linear shipments, instead of gaining revenue and share through trade promotions Software applications for collaboration and multi-tier coordination Methods to mitigate the impact of the Bullwhip

16. Keep your Closest Eye on Consumption • Timely Point Of Sale data gathering and analytics • Vendor Managed Inventory (VMI) • Collaborative Planning, Forecasting and Replenishment (CPFR) • Returns and Substitutions impact on signals • Plan future capacity and key component levels • Constraint management across the entire chain • Significant buffer(s) closest to customer • Minimize cumulative Lead Time • Prepare with speed and flexibility instead of inventory

17. Vendor Managed Inventory (VMI) • Customer provides a forecast of periodic demand (annual, quarterly, monthly, weekly) and supplier agrees to support with consigned inventory and without discrete purchase orders • Supplier monitors consumption levels at customer’s point of use and takes responsibility to replenish inventory • Supplier invoices customer for the amount of consumed inventory • Forecast is key to establishing consigned inventory targets, but consumption determines replenishments (not reaction to changed forecasts) • Examples include Coca Cola, Frito Lay, selected Proctor & Gamble products, several electronic component commodity suppliers Reaction to changing demand is likely to be limited to changes in Consumption, rather than to changes in Forecast

18. Smooth Production Flow (Walmart quarterly sales &production) Production peaks and valleys less dramatic than Sales peaks and valleys * Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

19. Returns & Buybacks Retailers negotiate the right to return to the supplier goods that are left over at the end of the selling season • How do they improve supply chain performance? • The retailer’s overage cost is reduced, so the retailer stocks more at the beginning of the season, reducing the need to cover unexpected bumps in sales with reactive supply signals • Allows for the redistribution of inventory risk across the supply chain. • Could protect the supplier’s brand image by avoiding markdowns. • Allows the supplier to signal that significant marketing effort will occur. • What are the costs of buy-backs? • Administrative costs plus additional shipping and handling costs. • Industries where this is a common practice include books, cosmetics, music CDs, agricultural chemicals, and electronics * Adapted from Cachon, Matching Supply with Demand, Third Edition, McGraw Hill Irwin

20. Leverage connectivity and applications • Utilize ERP applications for transactions and data warehousing but with additional analytic tools to enable execution • Attempt “optimizing” but understand tradeoffs • Manage multiple tiers simultaneously • Calculate multiple “what-if” scenarios and choose based on business rules and established prioroties • Ensure that sufficient networking and security requirements can be met and scaled • Ensure training and discipline throughout all levels of the Chain

21. A few Final Points • Forecasts should represent the best estimate of how many and when items will sell - not an attempt to manipulate, or influence, Supply • Lead Times should be established based on expected volume and processing times - more is NOT better • It is preferred to react more to what customers DO than to what customers MIGHT do • Safety stocks should be held in ONE level of assembly (FGI for BTS, key components and subassembly for BTO, ATO • Supply Chain coordination benefits greatly by leveraging technology • “Honesty” really is “the best Policy”